Mastering the Market Cycle

Nov 2, 2018

Risk is unknowable future, for gains and losses.

An edge is an information edge, tendencies (likely to happen) need to take into account factors. Hard to know how far back, impossible to define when “cycle starts or ends” but can look at peak to peak or trough to trough. Regression to the mean. Mean generally has a secular trend upward. Events can build on each other like stored energy, do not happen in isolation. Largely driven by psychology.

Returns are better when investors are fearful and worse when greedy.

Different types of cycles that can interact.

One time events Are difficult to identify the tendency, given lots of exgenerous factors, I.e. earnings calls

Long term cycles: Since GDP = hours worked * productivity. GDP therefore is largely impacted by birth rates. Drive to work (vs communism), automation (vs loss of people working and consumption). Averge generally goes up.

Short term cycles: psychology, yearly GDP doesn’t really matter. wealth effect, people feel good spend more. Unconventional Forecasts are rarely right and can’t be used generally, mainly gambling. Hindsight bias priases these people.

Government’s cycles: central Banks, Hawks make changes fast and perhaps too far. Doves help growth with stimulation packages. Deficits that help drive demand can be useful for growth. CBs try to drive counter cyclical, very hard to get right.

Profits cycles: larger effect on some companies rather than others. Food and Staples are more consistent, industrial equipment is closer. Very dependent on type business. Sales growth (GDP) does not = GDP due to costs.

Fixed income = known loss because equity holder loose before debt holders, a fixed outcome. If company is pure equity, any loss or change in operating behavior flows directly to bottom line (net income). Debt is leverage and shows up more on net income incases of changes to operating costs, financial leverage at work.

Investors psychology cause excess swings. Greed, fear pendulum. There are others. Euphoria > Optimism and depression. This also effects between skepticism and potential. Affects how people came the future.

Superior investor, few people are even keeled. Looking at intrinsic value + future value.
Emotional driven actions follow either: Selective perception and skewed interpretation. Not the data or events rather how people interpret them.

Risk

Events aren’t predicable and hence risk, primary challenge. We can only deal with environment as it is. Risk is not linear wrt return, appear to have higher return.

Risk aversion changes based on environment. Change premiums, lose interest in the lower end of the spectrum. Changes the capital markets line, the slope of line is how risk averse is the market.

Credit spreads, government 5 to corporate 6, as trust flows that way, same with maturity, hence credit spreads and yield curves.

Story about yields on bonds during financial crisis, and consecutive negative questions about “how bad can it get”.

How much optimism is baked into the price? How much skepticism?

Look for optimism when pesissim runs amok. Investors typically oscillate between there is not a risk in sight, and I don’t wanna lose another dollar.

Credit cycle. Like A window, which can shut in an incident. GDP the only TV but if you percentage points from the trend line, profits only deviate by a few percentage points from the trendlines. Financial leverage causes reported profits to swing or widely.

Credit cycles can affect even short term borrowing towards long-term assets because people typically roll over these deaths and need new capital to continue funding. If you don’t have cash on hand to pay this becomes a problem in this affects financial institutions more.

If you lend it, they will build it, sometimes recklessly.

Money is just like any other commodity, when is cheap people lend with loose terms, this is the race to the bottom. This is how lending firms “compete” by offering successively worse deals, as credit is plentiful.